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Thursday, June 23, 2005

The Yergin Conundrum



Daveberta (which, quid pro quo, has become our unofficial blog of the week) raises one of the big questions in financial markets these days: where is the price of oil headed? The impetus for discussion is a new Cambridge Energy Research Associates (CERA) study which finds that fears about the world running out of oil are unfounded. In fact, as oil capacity is ramped up between now and 2010, there will be more supply than demand, bringing prices down to ‘well below’ the $40/barrel level from US$59/barrel at present. And even beyond that point, if there is an ‘inflexion’ (inflection?) sometime beyond 2020, world production capacity will hit an ‘undulating plateau’ (a comical term, as Daveberta notes). Simple supply and demand theory bears part of the near-term forecast out: even at lower crude prices a few years ago, oil companies began plowing money into new production capacity. With prices now having reached a record high (in nominal terms), the quest for increasing capacity to match the potential profits from high prices will continue, and potentially accelerate, eventually bringing production up and prices down.

Mind you, CERA's is a contrarian view, in a field dominated by pundits bullish (in the upward sense) on oil prices. This may result partly from CERA’s ‘bottom-up’ view, which looks at production on a field-to-field basis, as opposed to macro trends in world oil markets. That said, a couple of months ago, Goldman Sachs, which no doubt has a vested interest in crude futures, published a controversial report in which it predicted $100+/barrel oil was not out of the question in the near term, in the event of a supply shock (ie stemming from a terrorist attack). And this guy is even predicting that the sphinx-like Saudis, who have said they're able to double capacity in the long run(!), might run out of oil in the next couple of years – and needless to say, the consequences of such an event would be economically catastrophic.

My views happen to lie somewhere in the happy middle, although I have some doubts on the CERA study. I know better than to question Daniel Yergin, CERA’s founder and chairman, who is an extremely intelligent guy, a Pulitzer Prize winner (for his brilliant history of the oil industry, The Prize), and, ahem, a Yale Daily News alum. But I take issue with at least one of the study’s points, namely, it’s not clear that the rise in aggregate oil production necessarily translates into substantially lower prices (ie, possibly under $40/barrel oil by 2007). That is because of the nature of the output: CERA assumes that ‘unconventional’ oil, like the Alberta tar sands and ultra-deepwater sources, could make up almost 35% of supply by 2020. I’m no expert, but assuming that such production does leap, and oil supplies in the aggregate increase, isn’t it still pretty costly to extract that oil? And if ‘unconventional’ producers want to make a profit at Rockefeller-style margins, couldn’t the average price of a barrel head up? (Devil’s advocate to my devil’s advocate: maybe not, if Fort McMurray’s sages are any guide. And you can’t underestimate the role of innovation.)

Whether CERA's right about the longer-term, I think it's possible we'll see $70 a barrel, and I think it's pretty clear that the sub-$30 a barrel days could be over (the sub-$20s days certainly are.) Sad as it is to say, especially in recognition of the potential economic consequences, I think we need the scary views on oil prices as a way to move toward a sensible, comprehensive energy policy. The recent cooperation between the greens and the neocons could be one of the great pragmatic political movements of our time, and high pump prices, if they materialize, could bring to fruition Tom Friedman's wet dream of ending our dependence on Middle East oil.

2 Comments:

Blogger Mike McNair said...

That last sentence made me feel a lil' dirty

2:41 PM  
Anonymous Anonymous said...

The cost of producing a barrel of crude from oil sands has fallen well below the $20 mark.

That cost may be higher than the cost of producing a barrel of oil from "conventional" sources, but oil sands production does have significant advantages. Primarily: there is no risk. Conventional oil producers face significant risk in that they must continually replenish declining supplies of oil with new discoveries. This is costly and by no means certain. Oil Sands producers, on the other hand, may face higher production costs, but they face no uncertainty whatsoever. They are, essentially, running an oil mining/money printing factory.

4:45 PM  

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